We hear from business owners constantly that they are making profits, but don’t have a lot of cash at the end of the year to show for it. One big reason is that they are constantly investing in their businesses. This concept of “reinvesting” profits frequently occurs, especially in growing businesses where the expected payoff is down the road. What often gets overlooked however is the importance of where, why, and how that investment is occurring. And the answers can be key to accelerating growth and managing cash and the business overall.
Why does this matter?
A key word we stress is intentionality in actions and choices within a business – in simple terms, telling money where to go. And, next, what should that investment result in? Sometimes the investment is long term in nature, meaning the ROI will be long term as well, but it can also be short term. Sometimes an investment feels like a simple cost of doing business, for example hiring a new team member, such as an inventory manager. However, that role should improve control over inventory, meaning a reduction in potential losses or inventory shrink. It may be indirect, but there is still an ROI on that investment. Business owners need to understand where they are investing in the business, and what they expect to generate as a result.
The ability to go back and revisit what actually happens relative to what was expected is an essential learning tool for further decision making. This is also critical in evaluating options. Small businesses operate with limited resources, and are all about choices, sometimes tough ones. So let’s look at some key areas where investment occurs:
CapEx – An obvious area of investment is capital expenditures. This could be new equipment or an upgrade to equipment, IT, real estate or vehicles. This won’t show up in the P&L directly. So how can you clearly bucket and track these investments over time? And before an investment is made, what is the business case? Is that a better use of funds than others?
People – People are a huge area of investment in businesses. This could be adding a key executive or operating role to allow for better efficiency or scale. It could be in accounting to handle additional sales volume. Maybe it is time to add a role in house, such as HR. These are all areas of investment in the business. The organization of tomorrow has to be built, and that building means investment. And whether direct or indirect, how do these investments impact profits, risk and asset growth?
Marketing – Marketing comes in many shapes and sizes, so a distinction here is key between ongoing and an investment. Marketing such as Google Ad spends are clearly ordinary course of business expenses, however, perhaps the business is exploring a new initiative such as building out a email marketing system, maybe there is a sizable upfront spend in imagery and physical materials, or even engaging an outside PR firm. There is an investment involved here for a longer term payoff.
Inventory – Many businesses in growth mode make investments in inventory. This could take the shape of a decision to carry larger amounts of in stock inventory to meet growth, or perhaps a buildup of inventory in a new product. This is a key use of cash that should have a tangible ROI. And while this will likely become the new norm, that initial buildup is an investment, and should be viewed that way.
Systems – Systems can take a lot of shapes and sizes. This could be a new cloud-based software platform. It could be more rigorous processes, such as a new manufacturing line configuration or the material addition of checks and balances. That spend is an investment. And while some will generate profitability and efficiency, they often reduce risk, protecting future profitability and assets. What capital needs to go to developing or upgrading systems?
Expansion – Some businesses choose to expand, whether geographically, horizontally, vertically or just by product or service offering. This category can be a catchall for multiple of the categories above like people and systems in addition to start up costs such as legal, compliance and testing.
The keys are to identify where money is going, track it over time and view the overall business to understand investment versus normal operations. Ask the questions, understand where things are headed and make educated decisions and evaluations. Years of high investment will often show lower cash balances and often lower profits as well to be followed up by higher profits in future years as the ROI is realized. Without a thought process around investment, how do you know if an investment is working? Should you do more or less? Can you tell the difference in your business? You want to.